RBI cracks down on misuse of alternative investment funds, tightens rules

The Reserve Bank of India (RBI) has tightened rules for banks, financial institutions and shadow lenders to stem the evergreening of loans via investments in alternative investment funds (AIFs).

RBI said that though regulated entities such as banks invest in units of AIFs as part of their regular operations, some transactions involving AIFs had raised regulatory concerns.

“The transactions entail substitution of direct loan exposure of regulated entities to borrowers with indirect exposure through investments in units of AIFs,” the RBI said in a circular.

“To address the concerns relating to possible evergreening through this route, it is advised that regulated entities shall not make investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the regulated entity,” RBI said.

An AIF is a privately pooled investment vehicle that collects funds from investors for investing by a defined investment policy to benefit its investors, according to the Securities and Exchange Board of India (Sebi).

“If an AIF scheme, in which the regulated entity is already an investor, makes a downstream investment in any such debtor company, then the regulated entity shall liquidate its investment in the scheme within 30 days from the date of such downstream investment by the AIF,” it added.

The notification further reads that if the regulated entities cannot liquidate their investments in the said period, they shall make 100% provision on such assets, adding that if regulated entities have already invested in such schemes, the 30-day period for liquidation would be counted from date of issuance of the circular.

The RBI’s notification to prevent the evergreening of loans has been a long-awaited regulatory step.

In May, RBI governor Shaktikanta Das said at a banking conference that the supervising arm of the central bank had noticed smart accounting methods adopted by a few banks to boost financial performance artificially, while urging bank directors to ensure the integrity of financial statements published by the lenders.

Das had then instructed the bank boards to engage with statutory central auditors to ensure that their financial reporting is transparent and prudent.

In his address to bank directors in May, Das highlighted that certain banks were concealing the true condition of their stressed loans through creative methods. These included tactics like coordinating with another lender for mutual loan evergreening through the sale and repurchase of loans or debt securities.

Das said reputable borrowers are being encouraged to engage in structured transactions with financially distressed borrowers. This strategy is used to hide the true financial distress by utilizing internal or office accounts. The manipulation involves adjusting the repayment duties of the stressed borrowers, either by renewing their existing loans or by providing them with new and additional loans. These additional funds are often directed towards repaying the borrower’s previous debts or to entities associated with them.

Das said that after these were pointed out by the regulator, such malpractices were being replaced by yet another method, and had sought to know “whose interest such smart strategies serve.”

Sebi had issued a circular in November last year, instructing AIFs not to accept any fresh commitment or invest in the priority distribution model until the regulator issues further instructions.